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Make The World Safe For `Creative Destruction'

February 22, 1998

Economic Viewpoint

MAKE THE WORLD SAFE FOR `CREATIVE DESTRUCTION'

Even though entrepreneurship is an elusive concept, economists have recognized its importance ever since the masterful analysis of economic development at the turn of the century by the great Austrian economist Joseph Schumpeter. Individuals with vision gambling their own and investors' money on new products is the engine that combines human and physical capital to fuel economic growth and progress.

A successful entrepreneurial environment features continual "creative destruction," to use Schumpeter's apt term. New companies prosper and help the economy in part by destroying the markets of established competitors. Examples include the growing competition to wired telephony from cellular phones, the eroded market for mom-and-pop grocery stores because of the greater efficiency of supermarkets, and the steep decline in IBM's market for computers, after the introduction of networking PCs by Sun Microsystems and other companies. Nations that protect the markets and incomes of existing companies prevent the creative destruction so essential to progress.

Although some cultures encourage entrepreneurship more than others, every culture has reservoirs of talent that come to the fore under a sympathetic business environment. Overseas Chinese thrived in business in Indonesia, Malaysia, and Singapore at the same time they were prevented from using their talents in communist China. Chile discovered enormous reserves of entrepreneurial ability after the free-market reforms of the 1980s.

RED TAPE. Regulations and red tape are major obstacles to the formation of new businesses. Among the most onerous are licenses and other requirements that greatly delay official approval for new companies. Some countries even require certification that a new company is "needed" in a particular locality or industry--an approval that is often refused.

Taxes on profits, capital gains, and estates are frequently so oppressive that they, too, discourage startups. Although the U.S. taxes corporate earnings and capital gains moderately heavily, loopholes are sufficiently abundant that many of the recent rich have amassed their wealth via new ventures. This is also true in Hong Kong, Taiwan, and Chile.

Unfortunately, European countries have erected serious barriers on this road to wealth. A good example is Sweden, rightly famous for the competitive efficiency of companies such as L.M. Ericsson, Volvo, and ABB Asea Brown Boveri. However, with few exceptions, they came into being from 1875 to 1915, the heyday of Swedish growth and free markets. Only a handful of major Swedish companies, such as Tetra-Pak Processing Systems, were created in recent years because of confiscatory taxation and equalitarian pressure in labor markets. Frustrated, some of the most successful companies, such as ABB, have moved headquarters and factories abroad.

TIME WARP. Even in European nations with many small companies, such as Italy, executives have complained to me about obtrusive regulations that discourage and hinder startups. These companies are impressed by how much more quickly they gain approval for factories in the U.S., though they are beginning to worry about growing litigation and environmental regulations.

Statistics from the Organization for Economic Cooperation & Development confirm that venture capital is more abundant in the U.S. than in Europe and that America invests much more of this capital in startups. Moreover, much startup money is devoted to risky high-tech companies in Silicon Valley and other centers of entrepreneurial energy.

One payoff has been job growth. Evidence indicates that smaller companies have provided about half of the new jobs during America's employment boom since 1980. By contrast, Europe has had essentially no overall employment growth in the private sector in recent decades.

Another advantage is the renewal of the vitality of large corporations. There are great opportunities in America for small companies to grow big. The Financial Times list of the world's 100 largest companies contains many European companies, but almost all of them were started many years ago. By contrast, Microsoft, Intel, Wal-Mart Stores, Hewlett-Packard, McDonald's, and other American companies on the list were formed only a few decades ago and became large as they succeeded.

I am amazed at the number of people who believe they will make lots of money by starting new companies. Most fail when they try to carry out their ideas. Still, these dreams drive an economy to new heights when encouraged by a sympathetic regulatory atmosphere and low taxes on profits, capital gains, and incomes.BY GARY S. BECKER